Select Committee on Social Security Minutes of Evidence



  A contributory system comprises two sets of rules. The contribution rules determine how individuals establish a contribution history. The payment rules determine benefit payments given a particular contribution history.

  In the National Insurance system, changes to the contribution rules have tended to widen the circumstances in which individuals establish a contribution history. In particular, there has been a move away from reliance on monetary contributions. Changes to the payment rules have, over the last 20 years, reduced the generosity of the benefits available to those with a given contribution history. Payment rules throughout the benefits system are now tending to focus relatively more on current income or health status and relatively less on previous contributions.

  Any case for a return to a benefit system more focused on previous contributions needs to make clear what such a system is intended to achieve. The private sector does not as yet provide a full range of insurance products against unemployment and sickness or disability, leaving a possible role for the state as insurance provider. But the private sector does provide pension income for old age. In pension provision, the main role for contributory benefits is in redistributing towards those with low lifetime incomes.

  The desire to avoid blunting the financial incentives to work and save might be advanced as reasons for favouring a contributory system of benefits over a means-tested one. But, fundamentally, such concerns are about means-testing—they are not directly related to the contributory principle. Indeed, it is quite possible that a benefit system which was principally contributory could produce these disincentives, and equally possible to think of design for a system with no contributory element which avoided them.

  One of the areas most in need of attention within the current contributory system is the overlap between health benefits and the labour market—it is not clear why we maintain a benefit that is a contingent on current health and previous contributions. In addition, the political risks associated with the potential that future governments may alter payment rules need to be reduced, probably through the provision of more transparent information on current entitlements. Finally, there is a need to assess whether there is any role for a contributory benefit in the labour market. The contributory element of Jobseekers Allowance is basically a historical hangover from the original National Insurance system.


What is the contributory principle?

  1.  All social security benefits are paid contingent on the recipient falling into a particular category. For example, Disability Living Allowance (DLA) is paid contingent on a person's current health status and Income Support is paid contingent on a person's current income. One of the defining features of a contributory benefit is that payments are contingent on events that occurred prior to the claiming of the benefit. For example, Contributory Jobseekers Allowance (Contributory JSA) is only available to those out of work who had previously been working and paying National Insurance Contributions (NICs). A contributory system therefore contains two fundamental sets of rules—the contribution rules that give rise to a contribution record and the payment rules which determine the benefit payments given a particular contribution record.

Contribution rules

  2.  The rules for establishing a contribution record were, in Beveridge's system, extremely simple. Virtually all paid workers made contributions, which consisted of flat rate payments. As benefits were also flat rate, there was a very clear link between work, contributions and benefits. There have been two major changes which have altered this simple relationship:

  3.   Earnings related contributions: these were introduced in 1961, extended in 1975 and again in 1985. Most recently, the current Chancellor announced the abolition of the "entry fee", leaving the flat rate element of NICs entirely superseded by earnings-related contributions for all but the self employed.

  4.   Non-monetary contributions. Since 1975 contribution histories have been credited to individuals in certain circumstances, such as caring for a young child or disabled person. From April 2000, the LEL will be increased creating a new group making non-monetary contributions. These will be people with earnings between the old and new levels of the LEL. Those with earnings below the old LEL will remain outside the National Insurance system.

  5.  The earnings related changes to National Insurance have left the system operating much more like an ordinary income tax than like the initial flat rate contribution system. For most benefits, higher contributions do not lead to increased levels of benefit entitlement. The extension of credits within the system has reduced the simple equation between being in work, contributing and benefit entitlement, which the 1948 system entailed. The current system is "contributory" only in a much broader sense than that envisaged by Beveridge.

Benefit Payment rules

  6.  The second set of rules in a contributory system are the payment rules, which determine the current benefit entitlement of a person with a particular contribution record. In the current National Insurance system these rules are highly complex. Rather than examine the individual rules, we draw out the essential themes that one might find in a contributory system.

  7.   Current contingency. In all cases, National Insurance benefits are dependent on the claimant falling into a particular category at the time of payment. The most important of these contingencies are old age, unemployment and sickness or disability. The payment rules may also involve a means-test based on current income. [1]

  8.   Length of contribution history. The level of payment of many National Insurance benefits, such as the Basic State Pension, is related to the amount of time that an individual has met the contribution rules.

  9.   Relationship with monetary contributions. The State Earnings Related Pension Scheme (SERPS) is currently the only National Insurance benefit where the level of benefit is related to the level of monetary contributions that have been made. SERPS is due to be replaced by the State Second Pension (SSP) from April 2002. Payments of SSP will initially be partially related to monetary contributions, but the pensions Green Paper envisages that within five years of its start-up SSP will cease to be earnings related.

Historic instability of payment rules

  10.  While the combination of the contribution and payment rules determine actual benefit entitlement, there is no fixed relationship between payments and contributions. Over time, one of the most notable feaures of the National Insurance system has been the degree of variability in the payment rules that have not been reflected in the contribution rules. In the past 20 years, changes in the rules have almost exclusively led to a reduction in the amount of benefit that is payable given a particular contribution history. These changes have been effected by a variety of means:

  11.   Changes in benefit rates. The single most important change affecting the level of National Insurance benefits was the removal of earnings indexation in 1980, which has had the compound effect of sharply reducing the relative value of National Insurance benefits.

  12.   Changes to earnings related components. After the introduction of SERPS in 1975, extensive changes in 1988 and 1997 significantly reduced the generosity of the scheme. In addition, earnings related components were introduced into Unemployment Benefit in 1966 but removed in the early 1980s.

  13.   Changes to rules on current contingencies. For Invalidity/Incapacity Benefit, there have been successive changes to the health tests that must be met in order to qualify for the benefit. Additionally, certain forms of current income have been taken into account in accessing payment levels. For Unemployment Benefit/Contributory JSA, entitlement has been reduced for those in receipt of occupational pensions since 1980. This provision is due to be extended to Incapacity Benefit.

  14.   Changes in the tax treatment of benefits. A number of benefits have moved from being untaxed to being taxed. For example, Invalidity Benefit was not subject to taxation, but its successor, Incapacity Benefit does become taxable after 28 weeks of receipt.

  15.  A further change that will affect levels of benefit receipt is the increase in the pensionable age for women, in alignment with that for men, due to be phased in from 2010. This will inevitably reduce the value of state retirement benefits to women.

Contributory benefits within the social security system

  16.  While the changes to payment rules for contributory benefits have tended to reduce their value, the importance of other elements of the benefit system has tended to increase. The overall thrust of policy in the last 20 years has been a move away from contributory benefits towards means-tested benefits. The graph illustrates this trend in terms of the growing importance of means-tested benefits and health-contingent benefits as a source of income for disabled people.

        Health-contingent benefits include Attendance Allowance, Mobility Allowance, Disability Living Allowance and Severe Disablement Allowance.
    Contributory benefits include Incapacity Benefit and its predecessors (Sickness Benefit and Invalidity Benefit).
    Means-tested benefits are Income Support payments to disabled people.
    Source: Social Security Statistics, various years.

  17.  These trends are set to continue. Partial means-testing and a tightening of the contribution rules are planned for Incapacity Benefit, while Income Support premiums for the severely disabled have been increased.

The future of the contributory principle

  18.  In the context of a fixed level of resources for social security payments, any change in the method of allocation must involve redistribution from one group to another. Any movement which reduces the degree to which benefit levels are determined by current income (means-testing) will imply a reduction in targeting on the poor.

  19.  Of course, most changes to the benefit system do not involve large initial redistribution. But large scale redistribution often comes about through the accumulation of the effects of changes over the longer term. So, while a "big bang" reorganisation of the system is unlikely, a change in the direction in which current policy is moving might be an attractive option.

  20.  If a case is to be made for future development of the contributory principle, one must be clear what this principle is intended to achieve. Here we briefly examine the main arguments for contributory benefits.

  21.   Correct for market failures. One of the main forces behind the establishment of contributory benefits was the failure of the market to provide insurance against certain contingencies. While this may have been the case for pensions fifty years ago, the rapid growth of occupational and personal pensions have demonstrated that the market is now able to provide annuitised income in old age. The market does not, as yet, provide a full range of insurance products against unemployment or sickness and disability.

  22.   Redistribution. The main argument for the provision of contributory pension benefits is that these can be used to redistribute resources to those with low lifetime incomes. This is the main role for the proposed Second State Pension, which will provide a better return on contributions for those with low incomes than would be available through private sector provision.

  23.   Incentives to meet contingent status. At the margin, contribution rules will affect peoples's decisions on whether to move into a status which generates a contribution record. The size of the effect depends on how people value the contribution record. However, for most states covered by the present contribution rules, the impact of the extistence of contribution rules on people's decisions is likely to be minimal.

  24.  The discussion of contributory benefits can become confused by a number of issues which actually have very little to do with the contributory principle. Rather, they are problems related to means-testing and have a bearing on the appropriate role for contributory benefits only in so far as contributory rules in a benefit system are viewed as a substitute for rules based on means-testing. The extent to which the two types of rule substitute for one another is limited, both by the possibility of a contributory system which incorporates means-testing, and by the recognition that there are alternatives to means-tested benefits which do not invoke the contributory principle, such as benefits like DLA that are conditional on health status only. Specific issues include:

  25.   Financial incentives to work. For the unemployed, the withdrawal of benefits on moving into paid employment reduces the financial incentives to work. The scale of the problem increases if the value of out-of-work benefits is high relative to the wage an individual expects to receive. This is true whether or not the benefits have a contributory element to their payment rules. Contributory benefits such as Incapacity Benefit and Contributory JSA that are withdrawn completely once a person enters employment can cause even larger unemployment traps than entirely means-tested benefits which are withdrawn via a taper as income rises.

  26.   Incentives to save. While the promotion of the incentive to save is sometimes cited as a reason to favour contributory benefits, disincentives to save are generated by the inclusion of the current level of savings in the payment rules of a benefit. This will be true whether or not the payment rules also depend on a contribution record.

  27.   Takeup of benefits. Low takeup of benefits is associated with high costs of claiming relative to the value of the payment, and also with the stigma that might be associated with certain benefits. Benefits that are means-tested on current income tend to suffer from low takeup as the payment rules are complicated, and because they involve high degree of intrusion into the claimant's circumstances. These problems exist whether or not the payment rules also include a contributory element.

  28.  Any reassessment of the future of contributory benefits must consider a number of areas in need of urgent attention. These include:

  29.   Overlap of sickness and labour market benefits. Most health related benefits are provided solely on the basis of current health status. The main exception is Incapacity Benefit, which is dependent on both current health status and previous employment history. The system may have been sensible in a world of families with one—usually male—breadwinner, whose incapacity would have resulted in a disproportionate reduction of the family's standard of living compared to the incapacity of the other partner. The system is increasingly less justifiable as traditional labour market patterns have broken down, and the benefit no longer provides anything approaching a replacement for earnings for most people. In addition, the fact that the benefit is withdrawn completely if the claimant moves into employment produces large disincentives to individuals moving back into work.

  30.   Political risk of contributory benefits. The potential benefits in a contributory system can be reduced by future governments. This "political risk" has been most notable in the case of SERPS, where entitlement has twice been sharply reduced as a result of changes to the payment rules. If the SSP is to be seen as an alternative to private provision for those with low incomes, then it must not be subject to such risks. At a minimum, those contributing to the scheme should receive regular notice of their accrued rights which would make transparent any reduction implemented by future policy changes.

  31.   Role of Contributory JSA. This benefit replaced Unemployment Benefit in 1996. It pays a small amount to those with sufficient contributions for a six month period. The benefit no longer provides even a modest level of earnings replacement for the majority of individuals, and most redistribution to the unemployed is achieved by the means-tested, non-contributory element of JSA.

  The existence of Contributory JSA seems to be an historic hangover from the original Unemployment Benefit in the Beveridge system. There is now a need to decide what, if anything, can be achieved by a contributory benefit in the labour market and to design a new benefit which is capable of delivering those objectives.

May 1999

1   It is important to note that the usual distinction between "contributory benefits" and "means-tested benefits" is merely a convenient short-hand. There is no logical distinction between the two types of benefit and it is perfectly possible for a benefit to have payment rules which depend on a contribution record and on the level of current income (as in the present reforms proposed for Incapacity Benefit). Back

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Prepared 9 December 1999